Federal expansion

Boost to Northern Virginia’s market not as big as expected. The big winner is D.C.

The commercial real estate market in Northern Virginia, like every other region of the country, has felt the arctic blast of the recent recession. Vacancy rates have gone up — and stayed up — and building starts have been nearly nonexistent.

But, as always, Northern Virginia has weathered the harsh financial climate way better than other parts of the nation because of the presence of that great insulator north of the Potomac, Northern Virginia’s equivalent of the big, puffy coat — the federal government.

“The federal government has always protected us on the down side of the business cycle,” says Stephen S. Fuller, director of George Mason’s Center for Regional Analysis.
That said, however, Fuller and other economic experts are skeptical that the 2009 American Recovery and Reinvestment Act (ARRA) — aka the stimulus package — has or will have a significant warming effect on NoVa’s commercial real estate sector. Fuller’s assessment: “A lot of talk about not very much.”

Art Turowski, senior vice president of Jones Lang LaSalle’s D.C. metro office, works with owners and investors seeking government tenants. His read is similar to Fuller’s: “Speculative construction won’t be warranted.”
Toeing the same skeptical line is David Lipson, executive vice president of Studley’s Washington, D. C., office. Studley Inc. specializes in tenant representation. Companies don’t make long-term commitments when they are concerned about business, Lipson says. Despite the stimulus and hopeful signs in the economy, most companies are still skittish.

“Inactivity” is his succinct characterization of NoVa’s commercial real estate sector last year. He expects chilly market conditions throughout 2010, with a probable thaw not setting in until next year.

On the surface, this view of NoVa’s commercial real estate sector seems unnecessarily negative, given the region’s status as one of Virginia’s biggest job engines. After all, major companies such as Hilton Worldwide and SAIC recently moved their headquarters here, and now defense giant Northrop Grumman is considering the area as well. Plus, it seems natural that this government-dependent region would expect a substantial effect from a jaw-dropping infusion of money into the U.S. economy.
Parsing the numbers, though, explains the skepticism.

Although many government agencies will spend ARRA funds in Northern Virginia during the next two years, the fed’s landlord agency, the General Services Administration (GSA), may be the best barometer of how much direct stimulation the Northern Virginia market can expect.

The GSA manages federal buildings and handles the leasing of commercial space to agencies throughout the country. It is the Big Foot of the National Capital Region, defined as the District of Columbia, Prince George’s and Montgomery counties in Maryland, and Arlington, Fairfax, Prince William and Loudoun counties in Virginia. In this area alone, the GSA owns 42 million square feet of space and leases an additional 53.6 million.

As part of the ARRA bill, the GSA is getting less than 1 percent of the $787 billion, or $5.5 billion. Because of the massive federal presence in the Washington area, the National Capital Region is snagging a disproportionate share of that — about $1.1 billion. To put this number into perspective, Michael McGill, the GSA’s press officer for the region, says that $1.1 billion is three times his agency’s normal annual capital budget.

So the GSA stimulus money would seem to represent quite a bonanza for the region, but for NoVa, not so much, as it turns out.

The ARRA mandates that the GSA spend its stimulus funds on construction and modernization of its own properties, particularly to increase energy efficiency. More than 33 million of the 42 million square feet the GSA owns in the region is located in the District, with most leased space located in the suburbs. GSA owns only 3 million square feet in Virginia and 6 million square feet in Maryland.

The result? Only two GSA buildings in NoVa qualify for stimulus money: the Martin V.B. Bostetter Jr. U.S. Courthouse in Alexandria and the U.S. Geological Survey’s Advanced Systems Center in Reston. The GSA will spend $1.7 million on the courthouse and $700,000 on the Reston building for what it calls “limited green rehab.”

The GSA’s biggest project ever falls in D.C.: the $450 million transformation of the western campus of St. Elizabeths Hospital into the new headquarters for Homeland Security. By completion, the project is expected to have vacuumed up a breath-taking $3.4 billion in federal funds. (Not to worry, taxpayers: That figure includes the furniture.)

Another big stimulus project in the District is the renovation of the GSA’s own 700,000-square-foot headquarters in Foggy Bottom. The $161 million renovation of the 1917 building is slated to begin in 2011 and last five years.

This is happy news for Washington’s commercial real estate market, which will benefit from the project’s spillover effect: The GSA will need temporary swing space while the project is in progress, and it has chosen to lease all of it in the District to minimize disruption to its employees.

About 280,000 square feet will be in “NoMa,” the city’s booming new commercial area “north of Massachusetts” Avenue. Tom Finan, managing director for the Washington metropolitan area for Trammell Crow Co., says that GSA will join other federal agencies that recently have leased space in NoMa, including the Department of Justice (575,000 square feet), the Internal Revenue Service (171,000 square feet), and the Equal Employment Opportunity Commission (170,000 square feet).

“Government activity in D.C. has kept the market stable and healthy, though rates are down a bit,” Finan says. He adds that with the help of so much GSA leasing activity, the District is “well on its way” to absorbing the oversupply of commercial space left from 2007 and 2008. According to CoStar Group Inc., a Bethesda-based real estate research firm, the District’s office vacancy rate for the fourth quarter of 2009 was 11.8 percent.

Meanwhile, in Northern Virginia, vacancy rates still run as high as 13 percent. It “has a longer haul” ahead than the District, Finan says, because even though GSA leases more than 20 million square feet in NoVa, including a recent plum for Arlington — 350,000 square feet for the Defense Advanced Research Projects Agency in Ballston — that activity is not enough to support the market.

In fiscal ‘09, the GSA awarded 80 leases of 3.5 million square feet in Northern Virginia. More than 20 were for 500,000 square feet of newly occupied space. McGill calls this expansion “normal annual activity.” Each year, he says — with or without a stimulus act — GSA’s space needs increase by about 10 percent.

But leasing by government contractors, which usually parallels government growth, so far has not followed suit. This delay may be because general stimulus funds, which might encourage contractors to lease new space, are slow to be disbursed. Another reason, as George Mason’s Fuller notes, is a six-month lag between government activity and the contractors’ response.

Even so, Lipson of Studley Inc. expects to see few long-term commitments from nervous government contractors this year. Short-term leasing should pick up as some Defense Department agencies, expected to move out of the area under the Base Realignment and Closure program, aren’t ready to go yet and need to extend their leases.

Finan of Trammel Crow seconds that. His company bought no buildings in NoVa in 2009, but, he says, it “will be looking for opportunities” this year and next.

Meanwhile, the bottom line seems to be that the stimulus is not all that stimulating for the Northern Virginia commercial real estate market. It may mean sunny days ahead for Washington, D.C., but south of the Potomac, it still is too soon to mothball the muffler and mittens.